Buyers are not just committed to a single mortgage or loan forever. But when buyers are dealing with multiple mortgages and refinancing options, how do you know which one takes priority? For the answer, you need to understand mortgage subordination.
What is a subordinate mortgage?
Homeowners may take out multiple loans to buy or renovate a home, but the first mortgage loan you take out usually remains “supreme.” If you can’t make your mortgage payments or the home is sold, the first mortgage lender will receive payment before anyone else. Primary mortgage lenders rarely want to give up this spot and prefer that subsequent mortgages are “subordinate mortgages.”
When does a mortgage become subordinate?
Any mortgage after the first existing mortgage will become the subordinate, or inferior, mortgage. A second or third mortgage can help you pay off the primary mortgage if you find that you are running into trouble making payments, but lenders may need to establish the rankings of these different mortgages first. If you are looking to refinance your first mortgage, you should alert the lender that you are taking out additional loans. They may ask you to sign a subordinate agreement before you get your money.
About Subordinate Agreements
When buyers want to refinance their first mortgage, the mortgage lender may require the buyer to sign a subordination agreement. This agreement basically lays out which mortgages are superior and which ones are subordinate. Buyers and lenders must take this agreement to a notary to make it official.
Buyers may have already agreed to the terms that they would find in a subordinate agreement. Mortgage lenders may include a subordination clause in the original loan agreement. Within the original agreement, subordination clauses state that any succeeding loans will be subordinate to the primary mortgage.
Can a first mortgage become subordinate?
A buyer’s first mortgage is not always the dominant mortgage. Subordination agreements can switch loan rankings and make the buyer’s first mortgage a subordinate mortgage. However, lenders are often hesitant to give up their spot.
Home equity loans are common second mortgages
The most common examples of second mortgages are home equity loans. These loans use your current home value as collateral and are typically an easier way to get cash to refinance the first mortgage or pay off other debts. Home equity loans usually come with shorter loan terms (10 years) and adjustable rates that could increase over time.
Home equity loans may come with higher interest rates since they are a subordinate mortgage. If you default, your home equity loan won’t be paid back until your primary mortgage is paid off. Buyers might also find themselves paying high closing costs to secure a second mortgage.
How does subordinate financing affect your future?
When you use your home as collateral, you risk losing it in the event of a default. Before you take out a second mortgage or home equity loan, it is important to assess your financial situation and how a second mortgage could affect your future.
In some cases, a second mortgage could be a great opportunity. Buyers can take out home equity loans for a one-time project (like a renovation.) If the buyer pays off the home equity loan on time, they can complete their project and improve their credit score.
Conversely, if buyers take out a subordinate mortgage that comes with high interest rates and a high down payment, they may start missing payments. Increased rates make this process even harder.
Before you take out a home equity loan or any sort of second mortgage, do some research. Map out your mortgage and figure out how much money you need to put aside for mortgage payments. Talk to multiple mortgage lenders about available rates (it won’t affect your overall credit score. Buyers have many options for refinancing their first mortgage or getting cash for renovation projects) quickly. Reach out to a financial advisor if you have questions about subordinate mortgages and refinancing options.